One strategy to lower your taxable estate is lifetime giving. However, there is a gift tax rate of 40 percent. If you have exhausted your $5.43 million gift and estate tax exemption, and you wish to lower your gift taxes, consider the possibility of making net gifts. This method obligates the recipient to pay the gift tax as a condition of accepting the gift, thereby lowering the value of the gift for gift tax purposes.

An example that reveals the ability of the net gift to save taxes is as follows. A grantor intends to make a $2 million gift to his son. Having used up his gift and estate tax exemption, he would like to reduce the tax. Applying a gift tax rate of 40 percent, if he were to make an outright gift, he would have to pay $400,000 in tax.

However, if his son agreed to pay the tax, there would be a reduction in the value of the gift, and thus, the gift tax liability. The formula that is used to calculate the tax on a net gift is: gift tax = tentative tax / (tax rate + 1). The tentative tax is the amount that would have been owed if the gift had not been arranged as a net gift. In this scenario, the tentative tax is $800,000. An application of the formula to this example results in a gift tax of ($800,000 / 1.4), or $571,429, which represents an effective rate of approximately 28.6 percent.

In order to make certain that his son receives the entire $2 million gift, the father can use a financed net gift. He lends his son $571,429 to pay the tax bill, which bears interest at the applicable federal rate (AFR), and is evidenced by a promissory note in writing.

What if, in this example, the father gave the son real estate with a fair market value of $2 million and a cost basis of $500,000? If the son pays $571,429 in gift tax, the excess of that amount over the father’s basis ($71,429) is a taxable capital gain to the father. You can avoid paying capital gains tax by engaging in a financed net gift transaction with a grantor trust instead of the beneficiary.

When participating in a net gift transaction, the recipient is required to sign an agreement expressing a promise to pay gift and estate taxes upon receipt of the gift. Prior to signing the contract, the recipient is advised to consult an estate planning attorney.

When making investment decisions, people often consider whether they should use an active or passive strategy. Passive investing attempts to duplicate the returns of the market as a whole.

This strategy does not involve the selection of securities by a portfolio manager. Without a portfolio manager to track the way an index performs, the cost of using a passive strategy is extremely low. It has also been suggested that the additional value provided by a portfolio manager is canceled out by any fees, costs and taxes.

However, if you possess securities in that index, you will never outperform the index. In addition, if you use a passive strategy, and the market experiences a decline, you will take part in that decrease in value.
In contrast to passive investing, active investing uses a manager who tries to produce returns that exceed the index against which the portfolio is benchmarked. The majority of managers try to accomplish this by selecting stocks they believe are improperly priced in the stock market compared to what should be their actual value.

The two major benefits of using an active strategy are the potential to outperform the index and protection from a market decline. Managers and their employees may be able gain an understanding of companies that others may have overlooked. They have access to information that will enable them to execute a trade that can outperform the index. Moreover, they can increase cash by selling securities if they think the market is going to decline or they recognize issues concerning the companies before everyone else does.

A disadvantage of the use of an active strategy is the fees connected with a portfolio manager. The fund’s investors pay the salaries, rent, research and travel expenses for the manager and the manager’s team. An additional concern is that the manager may not be able to outperform the index on a regular basis.

The Hook Law Center (formerly Oast & Hook) offices are located in Virginia Beach, and Suffolk, convenient to the Peninsula, and Southside including the cities of Chesapeake, the Eastern Shore, Franklin, Hampton, Isle of Wight, Newport News, Norfolk, Poquoson, Portsmouth, Richmond, Smithfield, Suffolk, Virginia Beach, Williamsburg, Yorktown and Zuni. Content by elder law attorney, Andrew Hook and the Hook Law Center staff.